JCL Blog

Some time ago I wrote a post about the Apple Brand Promise where I proposed that the magic of Steve Jobs was making his customers feel cool for buying his products. I still think people buy Apple products because of the way it changes how others view them. People feel cool when holding an Apple device and not because it makes them more productive or smarter and clearly not richer, but because the Apple brand promise says cool people buy Apple devices.

Cool is almost impossible to fake, and there is no formula for becoming cool. Just ask any rock band, super model, or San Francisco restaurant owner -- cool is as impossible to predict as stock price.

Cool is also impossible to copy. Fake Rolex watches will never be cool. No one is going to remember the band that tried to be like A Flock of Seagulls.

Those who have been touched by the ferry godmother of cool all know down deep that the chances of becoming cool are about the same as winning the lottery. Feel lucky if you win, but don't start thinking it was because you deserved it.

Which brings us to Microsoft. Microsoft makes people productive and enables them to keep more of their money in their pockets. It is rare that one feels cool with a Microsoft product, but who cares! I will take smart over cool any day. Smart matters, smart is lasting, people who are smart got there on more than the luck of the draw. The Microsoft brand promise should be associated with smart -- not cool.

I think many of us have lost track of what the Microsoft Brand Promise is. If you know, feel free to post a reply.

When using W8 the other day (I mostly use W7), I did not feel smart or cool!

The Hawthorne Effect famously demonstrated the changes to worker productivity resulting from changes in work environment. Like many studies the key learning turned out to be somewhat different than anticipated. Initially intended to figure out if lighting levels or other environmental factors impacted productivity the result turned out to be that workers did better when working together to improve the conditions. The improvements were not dependent on the changes but on the process of working together to make the changes.

I have to wonder if the same thing is happening in the Microsoft/Google/Apple race for the hearts and minds of the workers. Each is courting the users with new and improved ways to be productive. Microsoft has of course dominated the worker productivity area with the Office suite and the addition over the years of Outlook, Access, Visio, and OneNote. Google helps workers find stuff and has innovated around the edges with priority inbox in gmail and better spam filtering and Google docs and drive. Apple has turned the world mobile, brought about the app revolution, and companies now shower iPhones and iPads on their employees like they used to do with sales trips to Hawaii.

I am 24 hours into using my new Windows RT Surface and all I can think about is how much work I could do on the thing. It has been 90 years since Elton Mayo did his study in Hawthore, IL, maybe it is time for a new study. We could call the key learnings the Microsoft Effect.

It was a relatively short time ago that computers were produced in the dozens, cost millions of dollars, and were run by the phone company, the government, and a few very big businesses. The most technological thing that a small business had was a cash register.

In an office environment like a law firm or an accounting firm, there were typists, and a copy machine, and the only cloud application was the connection to AT&Ts big computer (the phone). In some cases professionals had specialized tools -- I for example had my HP12C programmable calculator. I never programmed it to do anything though. Amazingly, HP still sells that very calculator - 30 years later.

Then came the PC and voicemail and email and mobile phones and well, we all became computer operators plus whatever our jobs had been before that. Now we spend so much time staring at the screen that we feel like computer operators all of the time -- so it is no wonder that we sometimes forget that we have actual jobs to do. Facebook even relieves us from having to pull away from the computer to waste time at the water cooler.

We have become much more productive despite the time we have to spend getting our machines to work for us. Since the introduction of the PC, GDP per capita in the US has grown from $27,000 to $47,000 per year. And that is the average for the entire country.

Keep in mind that workers that use PCs have done much better than the rest of the population, so the productivity has more than doubled for PC users. Advances in technology drive our economy and our ever improving quality of life. This is an easy argument to make when you consider that penecilin was an advancement in technology. A bit harder in the context of nuclear weapons.

These advances in technology have provided for us so much extra time and money that we don't know what to do with it all. Most of us have more than one computer plus a phone with computer like computing power plus maybe a tablet too.

There are two types of advances in technology: incremental things and game changers. New computing capacity that reduces the time to run a report from a giant database is incremental. New sensors that report every person's location, everything they purchase, and many of the things that they think and say into a giant database is a game changer.

The incremental things we get from technology are gains in efficiency that make one business more productive than another. Game changers are new capabilities that just could not be done before and that completely change the business environment.

As the cost of compute cycles comes down the incremental functions will blend into the background and deliver less and less profit to their makers -- so look out HP and Dell. Game changers will become the whole game and command more and more of the profits. And as always the pace of change will be accelerating. Very few companies have the will to change their own game. Apple did it with the iPhone and now generates half of their revenues from a product they introduced only 5 years ago. Google did it to the advertising industry -- but it remains to be seen if they can do it to themselves. Microsoft is in the process of trying to change their game with Windows 8. Will they be able to do it?

It is insteresting and instructive to take a step back from the big ecosystem builders and think about who their customers are and what they are selling. Just so we all start from the same point on the map, I am going to clarify that customers are the people that pay and they pay for whatever a vendor is selling.

Microsoft

This is a big week for Microsoft with the long anticipated Windows 8 launch. Even though I am very much looking forward to getting my MS Surface (hardware) this week, Microsoft is still the maker of software and its customers paid $16 B in the most recent quarter and generated $5.3B in profits including for operating system software ($3.2B revenue /$1.6B profit), servers and dev tools ($4.5B/$1.7B), and productivity and business software ($5.5B/$3.6B). This is highly profitable business with one half of all revenue returned in profits. You will notice that a bit over $2B is missing from this revenue analysis - because that is the amount MS generates from XBox -- without generating any profit. Ouch!

Simply, customers pay Microsoft for the software they need to be productive. Anyone who has tried to be productive on an iPad knows what I am talking about. Producers need Microsoft's products to produce.

Apple

Apple quite famously makes more revenue and profit on the iPhone than all of Microsoft combined. In its most recent quarter it generated $16.2 B of a total of $35B from the iPhone at 43% margins. Any company that can grow from zero in 2007 when the iPhone was introduced to over $60B in annual revenue from a single new product line - deserves to be the worlds most valuable company. Even more impressive is the $9.2B in iPad revenue last quarter from a product just 30 months in the market. However, as Apple is demonstrating with the change of the standard cable plug on the latest version of the iPhone - it is selling devices that are driven by their popularity, not by business acceptance.

So, customers pay Apple for fashionable gadgets and Apple cranks out fashionable gadgets like no one else.

Google

Google has revenues about the same size as Microsoft's. The most recent quarter concluded with $14.1B in revenue and $7.45B in profits. 75% of Google's revenue comes from advertising. Advertising was 97% before the acquisition of Motorola -- and Motorola now makes up 19% of Google's revenue. Google makes all kinds of software (gmail, Google docs...) but most users get those services for free -- and the customers are the companies that pay to place their advertisements where those users can see them.

So customers pay Google for advertising. Google dominates the search market with 65% of all internet search traffic.

When analyzed from the perspective of the paying customer it is almost hard to believe that these three companies are fierce competitors. No one buys Microsoft products to be seen with them in the first class lounge at the airport. Almost no one pays Microsoft for advertising. Just about everyone pays Microsoft to make their businesses run.

CRN ran a story this morning about how Microsoft is like Philip Morris. I know that expecting web sites to avoid link bait is like expecting candidates running for the oval office to tell the truth. Even so, this one is over the top. There are many companies with comparable growth rates to Microsoft. Picking the one that sells an addictive product that causes cancer and that spent decades undermining efforts to understand the effects of cigarette smoke -- is poor form.

The article did make one good point though: when channel partners pick the vendors they partner with, they are making investments. In fact, they are making very big investments.

CRN says that channel partners should partner with Apple, Cognizant, Google, Rackspace, and Salesforce.com instead of Microsoft because those companies are growing faster. Really?!?

Let's take this apart company by company:

Apple: Apple is in fact starting a partner program. Apple however does not have a single enterprise software app. It can offer a desktop operating system, and a productivity suite, but Microsoft has hundreds of products -- and most of them solve very real enterprise computing problems.

Cognizant: Most people have never heard of this company. It is in fact a $6 billion dollar company, but it is a consulting and outsourcing firm -- a competitor to most channel partners. I bet it is a very big Microsoft partner. So there really is no reason a solution partner would partner with this organization instead of Microsoft.

Google: Google is kicking everyone's behind in search. True. But I can't think of how it would make sense as a channel partner to give up Microsoft's partner program in exchange for Google. Google offers no side by side go to market capabilities to support partners. Even if we were to humor CRN and think for 10 more seconds about this one - how can a partner make any money deploying Google Docs? This is one of those cases where Google takes a dollar someone else is making and turns it into a dime of advertising for itself. So Google can take revenue away from Microsoft, but it does not have that dollar to share with its channel partners.

Rackspace: Rackspace is not even a software company.

Salesforce.com: Salesforce.com, like Oracle (where Benioff came from) has a nasty habit of eating its own young. A few companies have made a living working with Salesforce.com, but most get run over by their scorched earth sales team. And all of that to partner with a company that has one product. Oh sorry, two products if you count Chatter as a seperate product.

Microsoft has made its way in the world by working side by side with its hundreds of thousands of partners worldwide. There are some companies that are growing faster, but none that comes anywhere close to supporting a partner ecosystem like Microsoft does.

It is hard to imagine what CRN was smoking when they proposed that Microsoft was like Philip Morris!

The biz is all cranked up over the Apple vs Google Maps thing that came from the latest release of Apple's mobile operating system, IOS 6. See this article in the NY Times.

In the background however, Amazon has been building its own maps capability. In July of this year Amazon bought mapping company UpNext and I think Amazon could come from behind to leapfrog Apple and maybe even catch up to Google.

Impossible? After all, the reason that Apple has rushed its mapping solution to market before it is ready is because Apple needs user data to improve the service.

Amazon just happens to have a close relationship, a codependent relationship some would say, with delivery companyies like UPS and FedEx. UPS has 250,000 drivers! It would not surprise me if there are 500,000 drivers worldwide driving all day, every day, delivering stuff -- much of which is from Amazon. This year Google announced it has driven 5 million miles collecting mapping data. If Amazon got its 500,000 drivers to collect map data -- that would be only 10 miles for each driver. It would take more time to install the collection equipment than it would to surpass all of Google's collections efforts so far. Call it a week to install the stuff and by the end of the first day, Amazon would have 10x the data that Google has collected.

Not only that, but professional drivers in every market in the whole world could return much higher quality data than users could.

This year for my birthday I bought myself a MacBook Air (11 in). It is a cool machine, but the best thing I got out of it was an increased appreciation for the quality of Microsoft's Windows operating system. Two months later and I find myself reaching for my old Win 7 machine most of the time.

I suppose I like the Mac best when I am not using it. It is beautiful, light, and technically, its best feature is the speed at which it stops and starts. When I am done, I just close it. When I want to use it -- I just open it. My Windows machines have never been able to do that. If I close my Windows machine without completely shutting down, it fights with itself while in my briefcase until it runs out of battery. Then when I go to open it -- no juice left. Not only that, but then I boot to the black screen that asks if I want to repair my machine. Anyone who has ever gotten sucked into that option knows it is like heading out on a trip from Seattle to New York and deciding to stop by Moscow on the way. Definately not the fastest route to productivily using the machine.

One of the new features on the Mac that I was looking forward to was the thunderbolt to HDMI connection for an external monitor. It works, but in typical Apple style, they have decided a few too many things for me. For instance, if I expand an app to full screen on the external monitor, it banks out the laptop monitor. What on earth are they thinking? In fact, I have yet to find an app that expands to full screen in the way that I would want. Pages just blacks out the left and right of the screen and the doc is small in the middle. Crazy!

The final blow is the speed of Chrome. Google's Chrome browser screams on my windows machine but crawls on the Mac. It is so slow that I have to think that Apple is somehow throwing sand in its gears -- just to get back at the competition. I do find myself using Safari more often as a result, but it is the biggest reason I don't reach for the machine at all.

Most people are not crazy enough to use two or three machines at a time - so I suspect that my side by side comparison is not typical. Even novices will notice how slow Chrome runs though.

So I have concluded that Apple, like all of the other tech companies, is using its moment in the sun to cast the biggest possible shadow on its competitors. Could it be that they realize that they do not have the vison that Steve brought to the company and they have decided to hang on as tight as possible to the lead they have? Boy would that be sad.

After all of this, Time Magazine will probably name Apple the "person" of the year -- which will further seal its fate.

Vertically integrated technology companies like Apple and Oracle have established themselves in the center of the the consumer and enterprise ecosystems by building proprietary systems with just about every feature contributing to customer lock in. The strategy has clearly worked for them, so far. Getting new customers is going to get more and more difficult for them as the world moves away from lock in and the competition does something other than push customers away by throwing up ill conceived and poorly executed competing products or services.

In this context a diverse and horizontally oriented technology firm will have a once in a decade opportunity to establish itself in the center of the new world -- not unlike the way IBM did in the ‘90s. In fact, we can learn a lot from Lou Gerstner's playbook from nearly 20 years ago. Here are the three partner relationship management things a company could do to establish itself at the center of the technology world of the next decade:

Embrace Open

The difference between open-ness and open source are more nuanced than can be described in this post. One similaritiy however serves our purposes. In an open system everyone is welcome. Everyone. Some companies can do this and others just cannot get their brains around it. Companies that are insecure about the value they deliver -- build walls and moats. Companies that are good at what they do are the ones that can let everyone in.

Love Engineering Great Products

A company with an engineering pedigree and that is full of talented people that love building great products has what it takes to be open. Such a product focus injects confidence into the decision making about being open.

Deliver Value Every Day

The irony of the lock-in strategy is that its is a cancer that eats the host from the inside out. IBM has shown us that the discipline of being open inspires everyone in the company to deliver value every day.

A company that works to immobilize its customers with contracts and proprietary and non transportable systems sends a message to customers -- but more damaging is the message it sends to the people inside the company. Soon the company is hiring more lawyers than engineers. And that cannot end well.

When I was a kid my mom taught me how to solve puzzles. She said to find the corners first, then the edge pieces, then assemble the frame, then sort the pieces by color... It was a sound process and surely was easier than randomly picking one of the 500 pieces out of the box and trying to figure out where it went. From that experience I learned that solving the puzzle depended heavily on the sequence.

It is interesting to see how the four big players in tablets computers: Apple, Amazon, Google, and Microsoft are each approaching their complex puzzles. Just like doing puzzles with my mom, the sequence is everything.

The first entrant into the market was Microsoft - over a decade ago. Bill Gates was correct that tablets were going to be big. We now know that his vision was extraordinary. Unfortunately, he was pulling one piece out of the box and there was really no hope of fitting it in with the other pieces.

Meanwhile, Steve Jobs was laying down the corners and the frame of his puzzle with the iPod. It was a simple but amazing device that enabled users to do one thing: carry 1,000 songs in their pocket. At the time the next best solution held only 10 songs. Then the iPod lead to the iPhone, the iPod Touch, all those apps and app developers, and finally the iPad. That final puzzle piece was easy to place in the picture because so many other pieces were in place already.

At the same time, Amazon was creating an amazing shopping experience for books and everything else in the universe on its web site. By the time it introduced the Kindle (same time as the iPhone in 2007) its puzzle was pretty well formed too. The Kindle put hundreds of books in your pocket and there really was not another alternative.

Just after that, in 2008, Google introduced its Android Operating System and the Chrome Browser. This story is a bit more complicated because Android was started outside of Google in 2003 and acquired by Google in 2005. Either way, the Google puzzle was being assembled well before the Samsung Galaxy Tab was introduced in late 2010. Add the proliferation of Android devices, 400,000 apps, and by the time we arrive at yesterday's announcement of the Nexus 7 a great deal of the Google tablet puzzle had been filled in.

It is true that there were a billion personal computers already running Microsoft operating systems when Bill Gates introduced his tablet in 2002. Surely that would form up the Microsoft puzzle. Right? So why does it seem like Microsoft is just now pulling out the first puzzle piece with the Surface and holding it over a blank table? Because Microsoft is trying to start a whole new consumer puzzle -- and all of its existing puzzle pieces make up an enterprise picture. Yes we use the Windows OS at home -- but it has not created any more of an ecosystem than Phoenix BIOS -- which we all run at home too.

It is going to be tough for Microsoft to complete its consumer tablet puzzle. The Surface may end up being a great device, it may get a great response from Microsoft's enterprise customers. But it is going to be hard to put the pieces together for consumers.

Lost in the fracus about Microsoft and its relationship with its partners is the new partner relationships that invariably are going to emerge. Microsoft has always been a partner focused company and will always be. But the partners do change quite a bit. Some people think that the partner ecosystem has a churn rate of as much as 30% per year.

Long time partners of Microsoft including HP and Acer have been quoted recently saying that were mystified about the move by Microsoft to develop the Surface and not consult them first. Many have predicted, including me, that partners will ultimately produce most of the Surface devices. The partners just may not be the ones that we think.

Apple did not start cold with the iPad. First came the iPhone and more importantly, the iPod Touch. In fact, according to the account in Isaacson's book, the iPad idea came before the iPod Touch and the work done on the iPod Touch was necessary to prove that the iPad idea was even viable, and of course to ensure that the product was insanely great.

Microsoft's OEMs might be frustrated with Microsoft's moves on the Surface, but they really should be looking at Samsung and HTC and maybe even Nokia. They are the ones with the expertise to build a Windows 8 tablet that could compete with the iPad.

PC Mag reported this week that Samsung may be working on its own operating system just in case it needs it to compete with Microsoft and Google in the tablet market. That is crazy talk.

The papers love to report on the consumer end of the tech industry. All the while, a great deal of business is being done on the enterprise side. Admitedly, the consumer angle is tough to resist because if I had put Apple on this chart it would be up 373% in this same time period. So it is easy to see how journalists get drawn to Apple and the consumer business.

This chart shows how the big enterprise players have performed over the past 5 years:

(click on the chart to go to Google Finance for a larger view)

Microsoft and HP, the two companies that are drawn to the consumer flame but also have a majority of their business in enterprise computing, have not done as well as Oracle and IBM -- who are completely focussed on winning the enterprise marketplace. Microsoft just acquired Yammer - which shows a focus on business computing, but they also introduced the Surface, which is aimed back at the consumer.

Now would be a good time to show the focus that Oracle and IBM have shown.

David Segal should look for a job at the Huffington Post. He is a good writer, and he knows some good link bait when he sees it. Today he landed above the fold on the front page of the Sunday New York Times with a non news piece about the wages Apple pays its retail employees.

There are two significant problems with the article:

It implies that entry level employee pay should somehow be related to CEO pay,

It implies that entry level employee pay should somehow related to corporate profits.

Neither is true and proposing that Apple should pay its retail employees differently for any reason other than to compete effectively in the marketplace is preposterous.

As an exercise, let's imagine that the Apple board calls an emergency meeting to respond to this article. A great deal has been written lately about how boards represent the interests of the shareholders, but for the sake of this hypothetical meeting, let's just pretend that the Apple board is higher quality than most boards and feels a responsibility to both the Apple shareholders and the Apple employees.

Here are the options I can think of for the board to consider:

Establish a metric that either increases employee pay or decreases CEO pay so that the two are closely correlated and don't get too far apart.

Decrease front line employee pay because the article ends saying that Apple has more applicants than it needs -- which indicates it pays too much.

Do nothing. There does not seem to be a shortage of willing employees, and the quality of employees is more than adequate to do the job.

One economic fact that is not reported in the article, but warrants a mention here is that any change that increases the pay of the current employees will provide only a small and very temporary benefit to current employees. The increased pay will attract more experienced, higher quality employees, that over time will displace the current employees.

Clearly the Apple board will not actually call a meeting, and the result of the article will not be any of the options that increase the pay of the current employees.

I am the CEO of a small company that has a large percentage of front line employees. We live and die by the performance of our employees and work very hard to find, recruit, and retain extraordinary people. From time to time we get into this very same discussion. Invariably the discussion comes when our profits go up. At times we have had profit sharing plans that distribute some of our profits to front line employees. In my experience, those plans are not a good investment because employees decide to come work for us by evaluating our environment and the base pay. A dollar distributed in profit sharing does not earn the company a dollar in value, because potential employees logically discount the potential of profit sharing as it is uncertain.

In lean years, it is common for owners of companies to pay more into the company than they extract in wages or dividends. This economic reality should not have any bearing on employee wages either. I have never heard of a company that has been successful recruiting great talent by telling them that during lean years they will have to pay to come to work.

The marketplace sets wages for employees quite efficiently. David Segal and the New York Times knows that quite well. Taking a swing at Apple on the front page is great link bait though.

The media loves a fight and the media is quite good at making sure there are plenty of fights to report on. It is true that Microsoft could have done a better job of getting its partners onto the Surface bus before it left the station, but it would certainly have sacrificed the secret, and the surprise. And the media also loves a good surprise.

Ordinarily I would put links here to articles supporting my thesis that the media is itching for a MS vs Partners fight, but there are so many articles I could not pick. Just search for "Microsoft Partners Surface" and you will see what I am talking about.

By the time Surface gets to market in the fall, this will all be forgotten. Here are some more specific predictions:

Will Microsoft let partners sell the Surface? Right now it is being reported that the device will only be available in Microsoft stores and on the Microsoft web site. I find it hard to believe that Microsoft will prevent its partners from selling the device. So I predict, that if MS can make enough of them, partners will be able to sell them too. Who knows, maybe MS is in the middle of big deal negotiaitons with Best Buy, or even Verizon, and so they cannot announce the distribution deals yet.

Does Microsoft want other great Win 8 tablets on the market? Microsoft did not refer to the Surface as a reference design, but I think it is a reference design. If the product is a hit, Microsoft will not be able to make enough of them. If it is a dud, no one will care. So Microsoft must want other PC makers to enter the market. In fact there is nothing Microsoft can do to prevent it.

Will this put Win 8 at the front of the line? To date the predictions in the business market have been pointing to wide adoption of Windows 7, and not so much for Windows 8. I do not think this will change that. Windows 7 is a great product and businesses are not going to jump to Windows 8 for this. It will be a great addition to the windows line, and now a business can give an exec a Surface running Windows 8 instead of an iPad. The billion or so installed PCs currently running earlier versions of windows, including 200 million still running XP, will be upgraded to Windows 7 (if possible) or not upgraded at all.

All around, great job Microsoft. You have introduced a credible competitor to the iPad. Microsoft Partners are better off today than they were a week ago -- and I am sure the partners know it.

USA Today has this good piece on Microsoft's complicated history with tablet computing. Just goes to show that having the idea is not enough -- even when you are Bill Gates!

Microsoft has been doing the tablet thing since at least 2002 and with its announcement this week of the new Surface, has a credible competitor to the iPad. Here is a pretty good treatment on Engadget covering the launch event. It is hard to get too excited without a deliver date or price. And when Steve Sinofski had to trade out his frozen Surface for a new one -- the pain was palpable.

Despite the long drawn out history and the incredible lead Apple has already established, this is going to be a very intereting fight. There are two contrasting views that I can think of: Consolidate or Extend.

Apple Wins if it Continues to Extend

Apple has done an amazing job of getting customers to extend their personal computing infrastructure to yet another device. We have all walked down the isle of the plan and seen an iPad at every other seat -- and practically every seat in first class. We know however that while many of these people may no longer travel with their PCs, they still own them. If Apple can continue to extend to the iPad -- Apple wins.

Microsoft Wins if Consolidation Happens

Microsoft's new Windows 8 operating system, that hits the market in the fall, will be optimized for tablet devices -- including the new Surface, to be built and sold by Microsoft itself. Clearly Microsoft is positioning this device to be both the tablet and the PC. To the extent that Microsoft can consolidate the market back from PC + iPad to a Win 8 PC only -- Microsoft wins.

Michael Dell used to say that the channel was the gift that just kept on giving -- and it was not meant as a compliment. A few years back Dell changed course and now has over 100,000 partners. In truth, partners were always a big thing to Dell. Only they would tell their customers what to buy and when the Dell boxes came in, the "partner" would show up make everything work. Now those people actually are Dell Partners.

Apple has also gone without the channel for much of its history preferring to let the products speak for themselves and the fans to figure out how to set everything up. Recently however, Apple has started courting partners more directly than we have ever seen before.

So now that Apple finds itself deep in the business environment as a result of the BYOD movement in IT, they are making an effort to take full advantage.

This will be interesting to watch. One thing Apple has always had as a result of their independence from partners or business customers it the ability to make their products without having to consider large customers. Microsoft, along with all of the enterprise focussed vendors, have for a long time had to collaborate with partners and customers on their product roadmaps.

Apple has not been very collaborative about this kind of thing in the past. So new muscles will have to be built.

The numbers in the Freemium business model are similar to direct mail. 2% of the users buy. Fortunately for the businesses selling their services through the Freemium model, serving the 98% is about as cheap or maybe even cheaper than sending out direct mail pieces. Better yet, the cost of servicing the users that don't pay is offset by selling access to them and their data to advertisers.

All good? Yeah! But wait, what happens when some other company swipes the 2%? In an emerging marketplace where new entrants create new sectors and then have them all to themselves, this all works great. But as the market matures and competitors flood in, it is pretty easy to see how there could be a company that gets the Premium customer and does not have to give away their service to 98 out every 100 users.

What if small businesses try out cloud storage with DropBox, but when it comes time to pay, go to Box? Box bills itself as the enterprise version of DropBox and it could play out that users perceive that it would be silly to pay DropBox when they could get an enterprise version at Box. Maybe this is why Box has been able to raise $150 million even while Google is entering the market with Google drive and Microsoft is entering the market with Skydrive. Could those companies be serving as Freemium providers just driving Premium users to Box?

This is what Apple has done. They dominate the Premium part of the hardware market and their share of the profits in the industry far exceeds their share of the market.

Yesterday I proposed that some higher than expected percentage of Apple’s sales came from channel partners. Today I propose that it is possible that 100% of Apple’s profit was actually paid by the resellers. Here is my math based on Apple’s 2011 annual report:

Looking at iPhone sales alone – event though this under appreciates iPad sales through the carriers, and sales of other products through BestBuy and Walmart. Apple sold 72 million iPhones in 2011 for total revenue of $47 Billion – 43% of all Apple revenue. Last month the Wall Street Journal reported that US Carriers pay Apple an average subsidy of $400 per iPhone.

Apple generated an average of $650 in revenue per iPhone – the channel partner is paying 61% of the purchase price of the device! If this is true, Apple received $28 billion from its channel partners in iPhone subsidies – more than all of Apple’s profits for the year.

True, Apple can and does in some cases sell the iPhone without any subsidy. But sales would be much less (like the WSJ reported in countries where the subsidy is not customary), and pricing would be under much more pressure.

Apple should be commended here – taking an industry where it is common to pay partners to sell for you and turn it into a situation where partners are paying more than half of the cost of product.

Can you imagine going into a car dealer and only paying 39% of the cost of the car, because the car dealer paid the rest to the manufacturer – all for a two year service contact!

Every computer / phone / tablet maker out there wants a deal like this. The question is, are the carriers going to keep doing it?

Apple has widely been perceived as a company that operates outside of the reseller channel. Its stores and web site sell directly to their customers and they have achieved meteoric growth without the help of the third parties that make the rest of the technology industry function. The prevailing belief in the industry is that there is no way to get to such a large market without the aid of channel partners -- that number in the hundreds of thousands.

The launch of the iPad gives us a good backdrop to examine if this is really true. Does Apple sell directly to customers or through the channel? Is there anything to learn from the recent success of Apple? I propose that Apple sells through the channel and there are some specific things that can be learned.

First, Apple has an awesome web site and some 300 or so stores that generate an average of $50 million in revenue per store. Apple generates more revenue per square foot than any other retailer – actually twice that of Tiffanies - the next most productive retailer. Despite this incredible performance, in 2011 Apple generated 15% of its revenue through its stores, it pales in comparison to revenue generated by iPhone sales of 45% -- three times that of its stores.

iPhones are sold by Apples new channel partners – the wireless carriers. If you add this to the sales by Apple’s other partners: BestBuy (1,000 stores) and Walmart (2,500 stores) and it is starting to look like a significant portion of Apple’s incredible growth is fueled by its channel partners.

Anyone who has found themselves in the role of family tech support person has been wishing for the post PC era for a long time. In fact, most PC users have used remarkably few features of the PC. Word processing, email, the web, and maybe a spreadsheet. They don't care about where their files are located, how the machine works or stays healthy, have never installed anything, or backed anything up. They are just not interested in the PC at all. As soon as these people got smart phones their PCs go days or weeks without being touched. Some overwhelmingly large percentage are these non PC users -- and for them the PC was a necessary evil -- they just wanted to send the email. So Apple is right.

Anyone needing to connect to a corporate network, or that uses databases, or that builds things (web pages, databases, programs), is going to need a PC and because they are the type of person that loves new technoligy they are probably going to want a tablet too. So HP is right.

According to Gartner, there were 93 million PCs shipped in Q4 of 2011. According to Apple, they shipped 15 million iPads in Q4 of 2011. They were just shy of HPs share (17 million) of the PC market.

Up until now, the iPad has been an extension of the users technology portfolio. From now on, the number of users with just an iPad (or other tablet) is going to go up fast. So Apple is going to win big and if Microsoft can get to the party with Windows 8, Microsoft will win big too. The people selling PCs like HP and Dell are going to see their marketplace rotate significantly -- and probably decline. All HP and Dell need to do is come to market with amazing Windows 8 tablets later this year.

A smart Wall Street guy recently described to me a new way to think about the value of a stock in an overheated market. He proposed that there were really two parts to value. The first of course is the underlying value of the share. And the second is the option the holder of the share holds implicitly to sell the share at a time of his choosing. This could be called the option to sell to the greater fool, but let's not start calling people names.

This second layer of value can be greater than the first. In other words, particularly in a momentum market, the right to sell is worth more than the stock itself. This is interesting because it is a good visualization of an emerging class of assets that derive their value entirely as a function of their relationship to an underlying asset.

Some will say this is nothing new. A steak at a steak house costs three times as much as a steak at home. Such an item could be described in two parts as well: the steak and the experience of eating it at the steak house. Again the second part is likely more valuable than the steak itself. Milk at the Mini Mart has two parts, the milk, and the convenience of buying it quickly.

In markets where innovation is changing the cost of producing and delivering things, the cost of the underlying asset is decreasing quite quickly. Take ebooks for example, the cost to create and deliver the next copy of an ebook is essentially zero. This creates an environment where it is easy to see how there is relatively more value in the second, derivative asset, than in the ebook itself. The derivative asset to an ebook could be merely the recommendation of the right book, or who is reading what book, or comments about the book, or quotes from the book. If you were about to pitch a big deal, how much would you pay to know what the person on the other side of the table was reading the day before your meeting? At the risk of offending the authors who clearly invest themselves in their craft and create valuable work, we must ask: Is there more value in the marketplace to the second level information about the book than in the book itself?

Apple, Google, Amazon and Facebook have been named as the new horsemen in technology. These companies recognize the value of being one layer removed from the actual asset. Google and Facebook both pay their customers (by offering free services) in exchange for this second level information – so clearly they assign value to it. Apple exploits the second level information less than the others – mostly because it’s history is making money selling devices. They are getting smarter about this all of the time and the Apple iCloud announcements last week betray their interest in being in the second level game. Amazon is the one with the superior business model. Not only does Amazon make money selling products, but they are expert at using the second level information to sell even more stuff. Amazon has a much more concrete awareness of what you “like” and knows how to use that information to present you with other products to purchase.

More examples of this construct emerge every day, and many in places commonly thought of as confidential:

Banks: I received an offer today from my bank to purchase access to their database of financial statements. These are financial statements their customers have submitted as part of their traditional banking relationship. Banks make money in many ways, and now they are making money selling access to the information they collect about their customers.

Phone Companies: The contents of your phone call cannot be “tapped” without a search warrant, but law enforcement regularly pays the cellular companies for the second level information. That data includes, who you called, how long you talked, and where you were (while talking or just while the phone was on). Law enforcement does not need probable cause or a search warrant to get this information and the cellular providers have automated access to the database, so the fees they collect are pur profit.

Credit Card Companies: Your credit card issuer makes 2 to 5% off of every transaction, plus they sell the information about how much you spend at what vendor. Soon you will be seeing advertisements on your credit card bill.

Where could this go next? Here are the services I would like to buy:

On the plane: I would pay extra to sit next to a thin person or better yet a client or potential client. In the case of the potential client, I would probably pay more than the cost of the ticket itself. This could also go for any event.

Buying Things: The next time I buy a house I would like to know which houses are going to come on the market next. So information about people looking to move, getting transferred, or experiencing other life changes would be valuable to me. Facebook could have this already, but other big databases will likely get mashed up to provide information like this.

Healthcare: The next time I get a cold or the flu, or better yet, before I get a bug, I would like to go online and see what is happening in my area. Who is suffering symptoms (Google has this because people do searches for their symptoms, the healthcare companies have it once people go to the doctor, and schools and employers have it once people call in sick) plotted on a map and compared to historical data.

The Government: The government could become the biggest player in this area. Think of the gold in the IRS’s databases.

Things are definitely getting interesting. Maybe my next post should be about privacy!